When it comes to taxes, the IRS wants to know almost everything about your financial affairs. But it’s particularly nosy when it comes to your offshore dealings.
And it’s not just people who live in the United States that need to worry about the IRS. If you’re a U.S. citizen or green card holder living abroad, you still have to bare your financial soul to the IRS each year.
Not only must you file a tax return and pay tax on your worldwide income, you must also comply with rigorous reporting obligations for your non-U.S. investments.
For 2010, there are two separate reporting obligations:
1. You must acknowledge foreign accounts annually on Schedule B of your federal income tax return, due April 15 of each year, or June 15 if you reside outside the United States. You can apply for a six-month extension to this deadline.
2. You must file Form TD F 90-22.1 (the “foreign bank account reporting” or “FBAR” form) annually with the U.S. Treasury Department. The deadline for filing is June 30 for foreign accounts held the previous year. No extensions are possible. The FBAR form asks how many foreign accounts you hold, their maximum value, the name of the financial institution where the accounts are held, the account numbers, etc.
Additional reporting requirements came into effect for 2011 and will apply to certain offshore investments made in 2010. However, the forms to acknowledge these investments aren't yet in their final form, so you will need to report them when you file your 2011 tax returns. I wrote about them here. Fortunately, you don’t need to worry about them currently to comply with your 2010 reporting obligations.
Unfortunately, it’s not always easy to figure out whether you need to report an offshore financial relationship or not. If you have “signature authority” over an account at a foreign bank or brokerage, this relationship is clearly reportable. But in the past, using the published guidance from the IRS, it was less clear whether you must disclose details of other offshore relationships.
However, on Feb. 24, 2011, the Treasury Department’s financial intelligence unit, the Financial Crimes Enforcement Network, issued final regulations clarifying these requirements. I wrote about them here.
The FinCEN rules spell out what other types of offshore investments are reportable to include:
"* Life insurance or annuity policies with cash value
* Accounts with anyone that acts as a broker or dealer for futures or options transactions in any commodity on or subject to the rules of a commodity exchange or association; and
* Mutual funds or similar pooled funds which issue shares available to the general public, with a regular net asset value determination and regular redemptions."
FinCEN also says it wants U.S. persons to report “an account with a person that is in the business of accepting deposits as a financial agency.” A financial agency is “a person acting for a person as a financial institution bailer, depository trustee, or agent, or acting in a similar way related to money, credit, securities, gold, or in a transaction in money, credit, securities, or gold.”
Basically, if you buy gold overseas and pay a custodian a fee for safekeeping it, that custodian is probably acting as a financial agency. On the other hand, if you keep the gold in a safety deposit box at a bank or private vault facility to which only you have access, the bank or vault likely isn’t acting as financial agency. This type of holding appears to remain non-reportable.
With the publication of this final rule, many U.S. citizens and permanent residents previously not required to file FBARs will now need to file them. And, a month later, FinCEN followed up with an updated version of the FBAR form. If you have offshore investments you need to report, this is the form you must use. Here’s the link.
And that brings up a potential problem. What if for 2010 you begin reporting as a “foreign account” an online gold account that you opened in, say, 2005? You never sold any of the gold you purchased in 2005, so you don’t owe any tax. But what if the IRS later discovers you opened the account five years before you first reported it?
They could penalize you, but the Treasury is being cagy on whether or not they will. When FinCEN first proposed regulations that would broaden the reporting requirements in 2010, it didn’t say anything about gold accounts not being reportable in prior years. Instead, it said: “FinCEN believes that compliance will be enhanced by more clearly delineating the types of relationships that must be reported.”
What’s more, the penalties for non-compliance with this reporting regime are mind-boggling, even if you paid every dime in tax you owed. For instance, the IRS has the authority to impose a civil negligence penalty of $10,000 per unreported account per year. The statute of limitations for unreported account violations is now six years, so for an unreported account from 2005-2009, the civil penalty in this example would be $50,000, plus interest. This assumes that there is no tax evasion involved—that you merely failed to file the FBAR, and/or failed to check “yes” on Schedule B.
As this penalty is not a “tax penalty,” but is instead authorized under Article 31 of the U.S. Code, you can’t contest it in Tax Court. Instead, you must pay the penalty and interest, and then sue for a refund in U.S. District Court. In addition, you’d likely have to pay a substantial retainer to an attorney in order to pursue the matter.
Conceivably, the IRS could even try to impose additional civil or criminal penalties for “willful” violations of the reporting obligations. In this context, “willfully” indicates an act undertaken intentionally or in deliberate disregard for the law. While the IRS must overcome a substantial burden to demonstrate willfulness, it could impose a willfulness civil penalty of up to $100,000 and then force you to sue in District Court to get it back.
However, if you’re in this situation, not all is lost. If you’ve paid all tax due on any unreported offshore investments you have, you have until Aug. 31, 2011 to fess up to the IRS without worrying about these penalties.
According to FAQs posted at the IRS Web site:
“For taxpayers who reported and paid tax on all their taxable income for prior years but did not file FBARs, you should file the delinquent FBAR reports according to the instructions (send to Department of Treasury, Post Office Box 32621, Detroit, MI 48232-0621) and attach a statement explaining why the reports are filed late. The IRS will not impose a penalty for the failure to file the delinquent FBARs if there are no underreported tax liabilities and the FBARs are filed by August 31, 2011. However, FBARs for 2010 are due on June 30, 2011 and must be filed by that date.”
There’s another important element to this deadline as well. Many U.S. citizens or permanent residents own or have interests in foreign entities such as corporations, foundations, LLCs, or trusts. The IRS wants to know about those too, and the penalties for non-compliance are in some cases even heavier than they are for unreported foreign accounts.
If you have filing obligations with which you haven’t complied relating to a foreign entity, now is the time to become compliant without worrying about these penalties. According to the same FAQs:
“The IRS will not impose a penalty for the failure to file the information returns if there are no underreported tax liabilities and the information returns are filed by August 31, 2011.”
If you take advantage of either of these provisions, you need to confirm that there were no taxable transactions in your accounts for these years, or that if there were, tax was properly paid. This is best done by an international tax professional familiar with the offshore reporting requirements.
Fessing up unreported offshore accounts may not be what you had in mind if you really want to expose yourself to the IRS. But, if you have an ambiguous reporting obligation, but owe no additional tax, it’s relatively painless to file the forms and amended tax returns for the years in question.
And if you want to end this outrageous invasion of your privacy? The only way to legally end it is to give up U.S. permanent residence and / or citizenship. My firm has helped dozens of clients “expatriate” in recent years.
Copyright (c) 2011 by Mark Nestmann
(An earlier version of this post was published by The Sovereign Society, https://banyanhill.com/)
